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For decades Toys R Us has made its living by immersing itself in all things toys. So it makes sense that the company's chief executive would use a beloved game as a metaphor to describe how it tumbled into Chapter 11 so suddenly, making the nearly $12 billion toy seller the third-largest retailer in history to go bankrupt.

In a document filed Tuesday in federal bankruptcy court, CEO David Brandon said news reports in early September that the retailer had engaged an adviser to help with its $5 billion debt load had "started a dangerous game of dominos."

In a matter of weeks after headlines appeared mentioning a possible Toys R Us bankruptcy, 40% of the retailer's suppliers refused to ship products without cash-on-delivery payments, cash in advance or even in some cases payment of all outstanding obligations, according to Brandon.

The dominoes fell as the company entered its most important three-month stretch of the year. For a retailer that makes most of its profit from fourth quarter toy sales, a supplier crackdown ahead of the holiday season amounted to a disaster. Brandon said, given the company's historic average of 60-day trade terms, the sudden demands for COD payments and other tight terms created an immediate, sudden need for more than $1 billion in liquidity.

Toys R Us was already laboring under a multi-billion debt pile — a legacy of its private equity buyout a decade ago — and shoveling $400 million in cash a year toward interest payments. The liquidity strain was too much. "The timing of all of this could not have been worse, as the company is in the process of building holiday inventory," Brandon said, adding that Toys R Us generates 40% of its annual revenue in the weeks before Christmas.

Ahead of bankruptcy, the retailer won an agreement with some of its creditors to provide a $3 billion loan to manage through the holidays, and it hopes to reduce its debt. All this is necessary for Toys R Us to keep its doors open in the short term.

Looking past Chapter 11, though, the retailer — the last among national pure-play toy sellers — must make tough, existential choices about what it wants to be and invest in ways to entice people to its stores and e-commerce site. And it needs to do all that in an increasingly competitive, $87 billion global toy market if it's to survive.

Caught in a 'shrinking center'

Financial strains, debt woes, concerns about the health of the retailer — Toys R Us has been here before, and not that long ago. Same-store sales have been negative for most of the last eight years. The company has posted a net loss for the past three years. It has undertaken turnarounds, relaunched its website, refinanced debt (multiple times) and brought in a lauded new CEO, Dave Brandon, who joined in 2015 and is perhaps best-known for turning around Domino's Pizza.

"The biggest change you are going to see over the next year is that we want to bring our toy stores to life," Brandon told Bloomberg just over a year ago. "I want kids to be dragging their parents to our stores because they want to see what's going on at Toys R Us this weekend."

And yet, traffic remains weak at Toys R Us stores. It continues to lose money. It struggled to clear out last year's holiday inventory. In the first quarter of this year, same-store sales fell by more than 4% and total sales fell by nearly 5% compared to the prior-year period.

"They're at risk of being caught in an increasingly shrinking center."

Greg Portell

Lead Partner, A.T. Kearney

Debt from the retailer’s acquisition last decade by private equity firms Kohlberg Kravis Roberts, Bain Capital Partners and Vornado Realty Trust has left it poorly positioned for adapting to a changing retail world, and it has largely created the company’s cycle of debt restructuring and financial concerns.

"For a robust retailer, debt payments can be challenging," Neil Saunders, managing director of GlobalData Retail, said in comments emailed to Retail Dive before the bankruptcy filing. "For a retailer struggling to generate sales growth while, at the same time, trying to invest to remain relevant — it can be the difference between success and failure." Saunders added at the time that Toys R Us' private equity owners treated it like an "ATM."

If the retailer has an enduring strength, it's brand. The company was founded in Washington, D.C., in 1948 when Charles Lazarus opened a baby furniture store. Lazarus served as CEO of the company into the 1990s. By then Toys R Us had more than 1,000 stores and had become a dominant big-box toy seller. The company hopes that millennials who grew up with the stores will start bringing their own children there, out of nostalgia.

But the toy market is rapidly evolving and, despite its efforts to make good on its brand prominence, the retail world still speaks of Toys R Us' need to excite customers and give them a reason to come in.

"They're at risk of being caught in an increasingly shrinking center," Greg Portell, lead partner for consulting firm A.T. Kearney's retail practice, told Retail Dive in an interview before Toys R Us filed for bankruptcy. "On the one hand, there are online players that can be more convenient. There are high-end bespoke toy shops that are much more curated. Then you have essentially a big box toy company that is stuck with an undifferentiated position and a cost base that doesn't reflect that."

Walmart and Target have become fierce competitors for Toys R Us, as has Amazon. Consulting and research firm Magid found that more than half of toy shoppers expect to shop in stores during the next year, but Toys R Us is no longer their first choice — the retailer trails behind Amazon and Walmart. According to consulting firm Fung Global Retail & Technology, online toy sales were 18% last year, and the number of parents who do most of their toy shopping at Amazon has doubled, to 14%, over the past five years. Low prices have driven customers to Walmart and Amazon, according to Fung, and price competition from generalists and mass retailers is tough on a retailer struggling to pay off its debts.

'Not surprised'

That puts Toys R Us in a bind. Compete on price, and Toys R Us loses precious cash needed to pay off debt. Hold prices steady, and it loses market share. Now add real estate costs that go with what many see as too many stores — nearly 1,600 — to a massive debt load coming to maturity in successive waves over the next few years — and it all created pressure that ultimately cracked the nearly 70-year-old company.

"I'm not surprised by the fact that Toys R Us filed for bankruptcy as these rumors have been circulating for the past week and its troubles in adapting to the post-recessionary economy were well documented, Tim Barrett, senior retailing analyst at Euromonitor International, said in comments emailed to Retail Dive. "Despite the need to belt tighten, the company clearly opted to use store openings to try and increase its absolute sales on a year-by-year basis. This strategy did not work."

Barrett added that in the past few years the company has experimented with new formats but these new stores did not help overall sales and didn't justify the money spent on them. "Even worse, the focus on these new store formats resulted in too little investment in making e-commerce a main channel," he said.

In issuing its second downgrade in days for Toys R Us, Fitch Ratings analysts wrote in a note on Tuesday that the the retailer's bankruptcy "comes on the heels of Toys facing a multi-decade onslaught of competition from discounters such as Walmart Stores and Target Corporation, and more recently, online only players such as Amazon, leading to market share losses."

The analysts pointed out that other retail players — such as Kroger in the grocery space — faced similar structural issues in their sectors but were not as indebted as Toys R Us and have been better able to maintain market share. Ray Hartjen, director of marketing for RetailNext, told Retail Dive that the company has a "great brand" and an "absolutely perfect retail model for 1950, 60, 70, 80 and 90." For 2017, not as much.

The publication reported that tackling the toy retailer's debt load could "give its major vendors such as Mattel and Hasbro clarity into the company's long-term viability to help ensure the toymakers continue to stock its shelves throughout the holidays." More reports followed noting that suppliers were starting to pull back and a Chapter 11 filing could be imminent.

Ratings agency S&P Global and then Fitch downgraded Toys R Us' debt amid the successive waves of stories from several news agencies. But the timing of the filing took some by surprise, as Toys R Us did not appear to be at imminent risk of bankruptcy. Analysts at Debtwire and Fitch, in interviews during the days between the initial news reports of the retailer bringing on Kirkland & Ellis and the filing, told Retail Dive that the company seemed to have enough liquidity to stock its shelves through the holiday season and into next year's debt maturity, which was $400 million compared to the headache-inducing $2.6 billion due in 2019.

"When you think about other players in the toy category — Target, Walmart, Amazon — they literally come in during the holiday and may have a display for six to eight weeks, then get out of the business in a meaningful way."

Monica Aggarwal

Retail and Consumer TeamHead, Fitch Ratings

But the supplier revolt changed the situation, and quickly. Circuit City faced similar demands from suppliers ahead of its 2008 bankruptcy, which came right at the start of the holiday sales season. However, the electronics retailer faced other challenges, too, that turned out to be insurmountable — namely a global recession and financial meltdown that paralyzed consumer spending and credit lending.

Much as the toy makers and suppliers might have feared a Toys R Us bankruptcy, they need the retailer around. "[Toys R Us] is an important outlet or distribution channel for some of the big toy vendors given it is the sole national player and it still is pretty significant in size," Monica Aggarwal, analyst and retail and consumer team head for Fitch Ratings, told Retail Dive in an interview before Toys R Us filed. "When you think about other players in the toy category — Target, Walmart, Amazon — they literally come in during the holiday and may have a display for six to eight weeks, then get out of the business in a meaningful way," Aggarwal said.

That could leave a toy market without the last national pure player more fragmented and give more power to the mass merchants who are not as dedicated to the market as Toys R Us.

From that perspective, a Toys R Us liquidation might be just as disastrous for the manufacturers as for the retailer. "In a way they might be too big to fail from a manufacturing standpoint," Hartjen said.

For now, though, the threat to the toy companies of the retailer's bankruptcy hasn't alarmed analysts. For the big players, namely Mattel and Hasbro, Toys R Us accounts for about 10% of their annual revenue, according to a Tuesday note from S&P Global. Analysts with the ratings firm held their debt grades for both Mattel and Hasbro, but they noted the bankruptcy could add pressure to their margins, profit and cash flow if they can't collect current receivables or can only do so slowly. The analysts also note that Toys R Us is likely to close some stores in the restructuring, which would force the toy companies to find other channels for their products.

Portell said he imagines some other national player, a kind of scaled-down Toys R Us, would emerge to "suck up the core" toy market if Toys R Us disappeared from the market entirely. "They are still sizable, so switching that much volume into other channels would be a bit disruptive," he said. "And you would expect someone could come in and capitalize on that, either either with smaller format stores, smaller curated product or something that's a bit of a fresh start."

Beyond bankruptcy: 'The jury is out'

Brandon and his company, amid the filing, have projected soaring optimism. In a release Monday, Brandon said that bankruptcy marked "the dawn of a new era at Toys R Us where we expect that the financial constraints that have held us back will be addressed in a lasting and effective way." In the court document he said the retailer's brand was one of the "most recognizable in the world," ranking in an outside marketing study ahead of Crayola, LEGO and Apple.

History has seen more liquidations than successful turnarounds for bankrupt retailers. But if Toys R Us can emerge from bankruptcy with less debt and money to reinvest in its business, the process could indeed mark a turning point. "With a reconstituted debt structure, and more predictable vendor support, Toys will have increased ability to make the investments necessary to improve its competitive position, beginning this holiday season," Charlie O'Shea, lead retail analyst for bond ratings firm Moody's, said in comments emailed to Retail Dive Tuesday.

"With a reconstituted debt structure, and more predictable vendor support, Toys will have increased ability to make the investments necessary to improve its competitive position, beginning this holiday season."

Charlie O'Shea

Lead Retail Analyst, Moody's Investor Service

"While today's decision does not necessarily mean it is game over for Toys R Us, it brings to a close a turbulent chapter in the iconic company's history," Neil Saunders, managing director of GlobalData Retail, said in a Tuesday note emailed to Retail Dive. "A combination of high debt and severe structural changes in the industry created a toxic mix against which Toys R Us had little choice but to restructure and try to put itself on a firmer footing."

Saunders pointed to the quick rise of online toy sales penetration, about 13.7% of the market today, according to his firm's estimates, and the retailer's failure to fully invest to compete in the new landscape.

"Looking ahead, lowering debt and streamlining the business should help to create a more sustainable operation," Saunders said. "However, even if the debt issues are solved, Toys R Us still faces massive structural challenges against which it must battle. The jury is out as to whether it can adapt enough to survive."

Tough choices

Assuming Toys R Us' bankruptcy proceeds smoothly and it's able to shed debt and win capital that could help propel a turnaround, can the company reinvent itself for the modern world?

The stakes are high, and so is the challenge facing the retailer. "The reality is that the market itself has been growing in the low single digit range, positive. So even if they stabilize their comp store sales at zero, they're still losing share long term," Fitch's Aggarwal said. "It's really what you can do at the in store level. Just executing online itself might not be enough to stabilize market share. Some of the concerns around in store is — this is a business that is highly seasonal, it's hit driven, and it's trying to figure out what you can do in the other three quarters when you're not driving holiday sales."

"You want a feel and a vibe and all those attributes to be positive and cheerful, and it's hard to do that when you're always looking at the next ghost to jump out of the corner at you."

Greg Portell

Lead Partner, A.T. Kearney

The company recently launched a new website, with the hopes of deeper penetration in e-commerce sales. As Brandon told Bloomberg last year, he was meticulously aware of the need to make physical shopping an experience. The company said in its most recent 10-K filing that it was working toward "bringing our stores to life" with featured stores-within-stores and demonstrations and interactive elements.

But a better website and new in-store features might amount to little more than window dressing. Toys R Us needs to make even more drastic decisions about who and what it is, and dramatically refashion their business to match that, Portell said.

"If you're going to be a high-end, high-touch retailer, then you're going to have a little more front line labor, you're going to have better merchandising, and you're going to have probably more infrastructure costs from an IT and a facilities standpoint," he said. "If you're going for convenience, then you pick the highest sellers and you lower all the costs you can. And if you're going to do that you're going to find yourself competing in a physical environment against online, and you just can't match that cost base."

Determining all that is no easy task. "The ability to define a course of action and fortitude to stick with it with everybody and their brother second guessing every decision you make" would likely be the toughest part of any turnaround for the Toys R Us team, Portell said.

Toys R Us should "invest in curation" — that is, differentiating its product assortment to house more exclusive or found-here-first products, which the company could finance through cutting corporate costs on things like IT and accounting systems, he added. Beyond that, Toys R Us needs a "spark" of some kind.

"Particularly in this segment, it's supposed to be fun," Portell said. "And while that seems maybe a little childish, you want an esprit de corps, you want a feel and a vibe and all those attributes to be positive and cheerful, and it's hard to do that when you're always looking at the next ghost to jump out of the corner at you. You can't operate out of fear in this space."

This spark, he added, could be a new licensing deal, a proprietary tie-in, an acquisition — if the company can muster the cash. "Or some sort of your own disruption: Maybe it's a puzzle subscription business, maybe it's a game-of-the-month club, just something that signals you're doing something different," Portell said. "But you want to create something that gets people excited, almost more so for the press and your employees more so than the consumer."